Wednesday, May 23, 2007

CPW/AOL UK – What is going on?

Some people have expressed surprise that AOL is raising the prices of its ipstream products for NEW customers by £10/month and extending the length of contract to 18 months, personally I’m not surprised in the slightest – the whole basis of the stock market valuation for Carphone’s broadband division is that it makes large profits in fiscal 2007/8 and even though Carphone has not announced full results yet for 2006/7, we are already two months into 2007/8. Carphone in 2007/8 will be chasing profits wherever possible.

The easiest way of making short term profits in broadband is stop large marketing bills (AOL did that months ago) and stop acquiring customers (AOL looks as if they have just turned the tap off in the non-LLU areas). Obviously there is a short term cash benefit as ipstream activation costs are not paid to BT and no more expensive bandwidth (BT Centrals) is needed to be ordered. But more importantly there is lower and more predictable support costs and the initial surge of new customers calling the call centre and provisioning efforts are halted.

For sure, some customers will want to churn to another supplier but TalkTalk should have by now a very experienced retentions team to try and hold onto them. Also, the churners will actually make the service better for the remaining customers as there are fewer customers to share the bandwidth.

So it seems to me, the current strategy with the AOL base is as follows:

0.5m acquired dial-up customers – run for profits, accept the churn and try to convert to unbundled broadband;

ipstream in a non-LLU broadband area – run for profits

ipstream in a LLU broadband area – unbundle to SMPF as the coverage is rolled out.

There seems to be very little marketing spend or attempt to acquire new customers. Personally, I think this is quite a sensible strategy. If in twelve months Carphone are finding that they have plenty of spare ipstream and support capacity or the economics of the market have improved they can move to being aggressive once again.

Remember also that the Carphone roots are in the mobile space and they will be quite used to operators turning the acquisition tap on or off according to budgets and available cash.

The more interesting question is how aggressively Carphone is going to compete in the fully unbundled (MPF) and partially unbundled areas (SMPF). Carphone currently has around 1,100 exchanges (16.5m homes within 5km) fully unbundled and is targeting 900 to be partially unbundled by March 2008. Note they are not raising the prices on ipstream where the exchange is planned to be unbundled.

The TalkTalk fully unbundled double play is still extremely aggressively priced, but the AOL partially unbundled is not currently looking especially cheap compared to the Sky and Orange pricing.

The latest evidence from the Openreach show an upsurge in unbundling activity to 55k gross and 42k net in the week ending 20th May. This is good news for someone and the upsurge is not necessarily all down to Carphone. The most worrying unbundling statistic is the churn percentage which is approximately 32% on an annualized basis. This is just far too high and will be ruining the economics of some players.

It is noted that TalkTalk is still offering its 30-day trial and someone who is unbundled and then quits would count in the Openreach generated churn numbers but probably not in the declared churn figures from TalkTalk. People who partake in the trial but do not sign-up for the 18-month contract will be massively unprofitable for TalkTalk, after all they will pay all the unbundling charges and only have one month of revenue.

Speaking of churn, 12th Oct is the 18-month anniversary of the launch of TalkTalk almost-free broadband and the date that customers go out of contract. Carphone will be hoping that there is not a mass exodus.

In summary, the initial 12-month land grab is over and Carphone is facing the same pressures as all the other operators – show us the profits…